Fed tensions send short yields sliding

U.S. government tariff revenues are bolstering the Treasury's coffers and its sovereign credit rating, but the durability of that cash flow is questionable and markets still question the country's clean bill of health.

Make no mistake, most forecasters have been taken aback by President Donald Trump's ability to level the highest import levies in a century without bowling over the entire economy - or at least not doing so yet.

The net result is that the revenue inflows from the tariffs are projected to pay for his signature "big beautiful" tax cut and spending bill and are stabilizing budget deficit forecasts, helping boost Uncle Sam's bruised creditworthiness into the bargain.

On Friday, the Congressional Budget Office - the non-partisan budget analyst of Congress - said Trump's increased tariffs could reduce the deficit by $4 trillion over the next decade. That represents a decline of $3.3 billion in the primary deficit and a related reduction of $700 million in interest payments.

A trillion dollars higher than its estimate in June, that would more than cover the $3.4 trillion increase in the budget gap that CBO has previously penciled in from the fiscal bill over the next 10 years. The increased tariff revenues from June are due to average tariff rates across countries and products rising about 4 percentage points to more than 18% in the two months since.

Graphics are produced by Reuters.

Two credit ratings firms already jumped the gun on those numbers over the past week, however.

Last Monday, S&P Global - the first ratings firm to strip the U.S. of its prized triple-A rating as far back as 2011 - affirmed its standing AA+ sovereign rating with a stable outlook.

The crux of its argument was simply tariffs. "We expect meaningful tariff revenue to generally offset weaker fiscal outcomes that might otherwise be associated with the recent fiscal legislation," S&P said in its statement.

Although still eye-wateringly high for a major economy outside of a recession, S&P projected the U.S. general government deficit to average 6% of GDP in the 2025-2028 period, down from 7.5% in 2024 and an average 9.8% from 2020 to 2023.

Lacing its report with more warnings and concern, Fitch - which lowered its AAA view of the U.S. as recently as 2023 - followed S&P later in the week and rubber-stamped its AA+ rating while also retaining its stable outlook.

However, its language showed some unease in doing so.

"The U.S. has not taken meaningful action to address its large fiscal deficits, rising debt burden, or the looming increase in spending tied to an aging population," it said, partly undermining its decision to waive new credit concerns.

It forecast the debt-to-GDP ratio to rise to 127% by 2027 from 114% last year.

Its defence? Citing the dollar's ongoing dominance as the world's main reserve currency as one factor in its relatively benign rating, the agency also forecast tariff revenues would jump to $250 billion this year from $77 billion in 2024.

Tariff revenue may explain some of the summer's bond market calm.

But investors continue to keep long-term borrowing costs and risk premia elevated and credit default swap (CDS) pricing suggests the U.S. sovereign rating should be closer to a single "A" rather than the "AA+" of the main agencies.

Graphics are produced by Reuters.

The Conference Board's monthly survey of U.S. consumers showed perceptions of the ability to find a job were at their weakest in more than four years in August, reinforcing the recent Fed dovishness about the unfolding state of the labor market. The survey showed the share of consumers who viewed jobs as "hard to get" jumped to 20.0% in August, the highest since February 2021, from 18.9% in July.

The proportion saying jobs were "plentiful" eased slightly. That pushed the survey's so-called labor market differential down to 9.7 from 11.0 in July. And that measure tends to correlate to the unemployment rate in the Labor Department's monthly employment report. The headache for the Fed of course is that inflation expectations are rising in tandem - consumers' average 12-month inflation view rose to 6.2% after easing for three straight months.

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